UNIT 6
DISTRIBUTION
6.1: DISTRIBUTION
Distribution in economics refers to the way total output, income, or wealth is distributed among individuals or among the factors of production (such as labour, land, and capital). In general theory and the national income and product accounts, each unit of output corresponds to a unit of income. One use of national accounts is for classifying factor incomes and measuring their respective shares, as in National Income. But, where focus is on income of persons or households, adjustments to the national accounts or other data sources are frequently used. Here, interest is often on the fraction of income going to the top (or bottom) x percent of households, the next y percent, and so forth (say in quintiles), and on the factors that might affect them.
6.2: THEORIES OF DISTRIBUTION
Some important definitions of ‘Distribution’ are as follows:
According to Prof. Nicholson – “Distribution refers to the sharing of wealth of a nation among the different classes.”
Prof. Chapman has said that – “The Economics of Distribution accounts for the sharing of the wealth produced by a community among the agents or the owners of agents which have been active in its production.”
According to Prof. Cannon – “Distribution like production is a social phenomenon. In production we study the creation of social income and in distribution we study its distribution in one case we regard it as national output and in the other as national dividend.”
According to Prof. Seligman – “All wealth that is created in society finds its way to the final disposition of the individual, through certain channels or sources of income, this process is called distribution.” Thus, the theory of distribution deals with the distribution of income. It seeks to explain the principles governing the determination of factor like rewards—rent, wages, interest and profits—i.e., how prices of the factors of production are set. The theory of distribution thus states how the product is functionally distributed among the co-operating factors in the process of production.
Functional Distribution:
Functional distribution refers to the distinct share of the national income received by the people, as agents of production per Unit of time, as a reward for the unique functions rendered by them through their productive services. These shares are commonly described as wages, rent, interest and profits in the aggregate production. It implies factor price determination of a class of factors. It has been called as “Macro” concept.
Personal Distribution:
Personal distribution on the other-hand, is a ‘Micro Concept’ which refers to the given amount of wealth and income received by individuals in society through their economics efforts, i.e., individual’s personal earnings of income through various sources
The concept of equality and inequality of income distribution and social justice is basically concerned with the personal distribution of income. Taxation measures are designed to influence personal distribution of income and wealth in a community.
The theory of distribution deals with functional distribution and not with personal distribution of income. It seeks to explain the principles governing the determination of factor rewards like—rent, wages, interest and profits, i.e., how prices of the factors of production are set.
The oldest and most significant theory of factor pricing is the marginal productivity theory. It is also known as Micro Theory of Factor Pricing.
It was propounded by the German economist T.H. Von Thunen. But later on many economists like Karl Mcnger, Walras, Wickstcad, Edgeworth and Clark etc. contributed for the development of this theory.
“The distribution of income of society is controlled by a natural law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates.” -J.B. Clark
“The marginal productivity theory contends that in equilibrium each productive agent will be rewarded in accordance with its marginal productivity.” -Mark Blaug
Assumptions of the Theory:
The main assumptions of the theory are as under:
Perfect Competition:
The marginal productivity theory rests upon the fundamental assumption of perfect competition. This is because it cannot take into account unequal bargaining power between the buyers and the sellers.
Homogeneous Factors:
This theory assumes that units of a factor of production are homogeneous. This implies that different units of factor of production have the same efficiency. Thus, the productivity of all workers offering the particular type of labour is the same.
Rational Behaviour:The theory assumes that every producer desires to reap maximum profits. This is because the organizer is a rational person and he so combines the different factors of production in such a way that marginal productivity from a unit of money is the same in the case of every factor of production.
Perfect Substitutability:
The theory is also based upon the assumption of perfect substitution not only between the different units of the same factor but also between the different units of various factors of production.
Perfect Mobility:
The theory assumes that both labour and capital are perfectly mobile between industries and localities. In the absence of this assumption the factor rewards could never tend to be equal as between different regions or employments.
Interchangeability:
It implies that all units of a factor are equally efficient and interchangeable. This is because different units of a factor of production are homogeneous, since they are of the same efficiency, they can be employed inter-changeable, and e.g., whether we employ the fourth man or the fifth man, his productivity shall be the same.
Perfect Adaptability:The theory takes for granted that various factors of production are perfectly adaptable as between different occupations.
Knowledge about Marginal Productivity:
Both producers and owners of factors of production have means of knowing the value of factor’s marginal product.
Full Employment:
It is assumed that various factors of production are fully employed with the exception of those who seek a wage above the value of their marginal product.
Law of Variable Proportions:
The law of variable proportions is applicable in the economy.
The Amount of Factors of Production should be Capable of being Varied:
It is assumed that the quantity of factors of production can be varied i.e. their units can either be increased or decreased. Then the remuneration of a factor becomes equal to its marginal productivity.
The Law of Diminishing Marginal Returns:It means that as units of a factor of production are increased the marginal productivity goes on diminishing.
Long-Run Analysis:
Marginal productivity theory of distribution seeks to explain determination of a factor’s remuneration only in the long period.
The modern theory of factor pricing provides a satisfactory explanation of the problem of distribution.
It is known as the demand and supply theory of distribution. According to the modem theory of factor pricing, the equilibrium factor prices can be explained by the forces of demand and supply.Prices paid for productive services are like any other price and they are basically determined by demand and supply conditions. Incomes are received as payments for the services of factors of production. Wages are payments for the services rendered by labour.
Rents are payments for the services of land and interest is payment for the services of capital. In this way most incomes are remunerations or prices paid for services rendered by factors of production in the process of production. This theory is superior to the marginal productivity theory, because it takes into account both the forces of demand and supply in the determination of factor prices. Marshall held the view that no separate theory is required to explain factor prices. The principles which govern commodity pricing also govern factor-pricing. The following paragraphs touch upon the salient aspects of the theory.
“The theory of factor prices is just a special case of the theory of price. We first develop a theory of the demand for factors, then a theory of the supply of factors and finally combine them into a theory of determination of equilibrium price and quantities.” Lipsey and Stonier.
Assumptions:
. Every producer tries to get maximum profit.
. Producers have perfect knowledge of the MRP
. Active competition exists in the factor market.
. There is active competition among the different units of factors.
. The state does not intervene to equate the prices of the factor service.
The quantity of land is limited, and so is its productiveness, and it is not uniform in quality. If the superior land will not support the population, recourse must be made to inferior lands and the produce is, thus, raised at different costs. The differential advantage of the superior land over the inferior gives rise to Economic Rent. It is plain that the farmer may just as well pay for the superior land as get the inferior land rent free.
Thus, rent arises out of the difference existing in the productiveness of different soils under cultivation at the time for the purpose of supplying the same market, and the amount of rent is determined by the degree of those differences. This is known as Ricardo’s Theory of Rent.
According to Ricardo, rent is that portion of the produce of the earth, which is paid to the landlord for the original and indestructible powers of the soil. It is a surplus enjoyed by the super marginal land over the marginal land arising due to the operation of the law of diminishing returns.
Productiveness depends on fertility and convenience of situation. Therefore, Economic Rent in its simplest form is the differential profit that arises in the case of production, owing to differences in natural conditions due to:
Fertility of the soil,
Advantages of situation.
Take, for simplicity, a new country dependent on its own supplies and occupied by a body of settlers. At first we may suppose that there is an abundance of the best land and that it is practically free. In this case only the best land will be used, and the produce will sell so as to just cover (with current wages and profits) the expenses of production. So far, there is no differential profit and, thus, no economic rent.
According to the modern theory of wages, wages are the price of services rendered by a labor to the employer.
As products the prices are determined with the help of demand and supply curve. Similarly, the wages (prices of services rendered by labor) is also obtained with the help of demand and supply of labor.
Therefore, for the determination of wage level, it is necessary to study the demand for labor, supply of labor, and the interaction between them.
i. Demand for a product:
Refers to one of the important determinant of demand for labor. The demand for labor is derived from the demand of the product it produces. In case, the demand for the product increases, the demand for labor would also increase However, this is the expected demand of the product and not the current demand. Therefore, the expected demand of the product determines the demand for labor. Moreover, along with the magnitude of demand, the elasticity of demand for labor is also need to be determined. The elasticity of output helps in determining the elasticity of labor.
a. Condition 1:
Labor would be inelastic if their wages contribute only a small amount to the total wages of industry
b. Condition 2:
Labor would be elastic if the product produced by him is elastic
c. Condition 3:
Labor would be elastic if cheaper substitutes of products are available
Elasticity of demand of labor depends on two factors, which are technical aspects of production and elasticity of demand for the product. The long-term demand for labor is more elastic than the short-term demand of labor.
Ii. Other factors of production:
Helps in determining the demand of labor. The price and amount of other factors of production employed affects the demand for labor. For example, if other factors of production are expensive then the demand for labor would be high. However, if other factors are available at cheaper quantity, then the demand for labor would reduce. Similarly, an increase in the demand of technology would reduce the demand for labor.
Supply of Labor:
Supply of labor refers to the number of hours spent by labor in the factor market. In an economy, there are several factors that influence the supply of labor. Some of the factors are wage rate, population size, age structure, availability of education and training employment opportunities for women, and social security programs.
On the other hand, in an industry, the supply of labour is less elastic in the short-run. In this case, the supply of labor is dependent on the accessibility of workers in the nearby areas and their willingness for overtime work. However, the supply of labor becomes more elastic in the long-run. Industries attract labor by providing higher wages, training facilities, and good working conditions. Therefore, the supply curve of labor for an industry is upward sloping.
Trade union gets existence under monopolistic competition. The trade union bargains with the employer on the issue of wage rate.
Generally, trade unions negotiate wages to be given to labor with employers.
This process of negotiating wages is called collective bargaining.
However, according to modem economists, trade unions contribute in raising wage rates by adopting the following measures:
i. Helps in reducing labor exploitation by ensuring that the wage rates are equal to VMP. This can be done by increasing the bargaining power of labor by trade unions.
Ii. Helps in increasing the MRP of labor through different ways, such as convincing employers to provide new and advanced machines to labor and inculcating the values of honesty and thrift among workers. Another way to increase MRP is by restricting the supply of labor.
Iii. Reduces the supply of labor by convincing the government to pass immigration laws, reduce working hours, and limit the entry of labor in the trade union. This is done to increase wage rates.
Iv. Helps in increasing the standard wage rates. If the standard wage rate increases, then it would automatically increases the wage rates of labor. This is a modern method adopted by trade unions for increasing the wage rate.
. The classical theory of interest is a special theory because it presumes full employment of resources.
On the other hand, Keynes theory of interest is a general theory, as it is based on the assumption that income and employment fluctuate constantly.
. Classical regard rate of interest to be equilibrating mechanism between saving and investment. Keynes regards changes in income to be the equilibrating mechanism between them. According to Keynes, savings depend on income. Classicals regarded savings as fixed corresponding to full employment income, whereas for Keynes for every level of employment, there will be a different level of income and for different levels of income there will be corresponding savings (curves).
. According to classicals, more savings will flow at a higher rate of interest, but according to Keynes savings will fall because the level of income will fall, for the investment will be less when the rate of interest goes up, leading to a decline in income and hence savings.
. The element of hoarding occupies a central position in Keynes’ liquidity preference theory of interest because he considers money as a store of value also; whereas the classicals gave little importance to the element of hoarding and considered money only as a medium of exchange.
. Classicals gave more attention to interest on bank loans, whereas Keynes was concerned with the entire loan and interest rate structure in the market and the complex of rates of interest that exist. In his theory, long-term rate of interest on loans, bonds and securities occupy greater significance as they influence long-term investment.
. Classicals always held that savings automatically flow into investment. Keynes held just the reverse, that is, it is investment that automatically leads to saving out of current income. Further, classicals held that investment could be increased by saving more but Keynes held that investment could increase income and out of the increased income, increased savings flow
. An increase in thrift, which according to classicals, was a great virtue, may according to Keynes, cause income to fall reducing the volume of savings. Hence, the classical position is falsified. It is one of the great merits of “General Theory” and the Keynesian approach of liquidity preference that it once for all cleared the thinking which confused the amount saved with the propensity to save. Thus, whereas classicals were keen to retain saving to investment as determining factors, Keynes omitted them completely from his theory of interest.
The following points highlight the four important features of Schumpeter’s theory of economic development.
They are: 1. Circular Flow 2. Role of Entrepreneur 3. Cyclical Process or Business Cycle and 4. End of Capitalism.
Feature # 1. Circular Flow:
Schumpeter starts his analysis of development process with the concept of circular flow.It implies a condition where economic activity produces itself continuously at constant rate through time.
Thus, it means a continuous activity and no destruction. It is the characteristic of an economy in stationary state.
The circular flow is similar to circulation in blood in an animal organism. Circular flow is based upon a state of perfect competitive equilibrium in which coasts are equal to receipts and prices to average costs. The Schumpeter, “The circular flow is a stream that is fed from the continually flowing springs of labour power and land and flow in every economic period into the reservoir which we call income, in order to be transformed into satisfaction of wants”.
The main features of circular flow are as under:
(a) All economic activities are essentially repetitive and follow a familiar routine course.
(b) All the producers know the aggregate demand for goods and adjust the supply of output accordingly. This means demand and supply are in equilibrium at each point of time.
(c) The economic system has the optimum level of output and its maximum use and there is no possibility of wastage of resources.
(d) The firms working in a system are in a state of competitive equilibrium.
(e) Under the stationary equilibrium, the prices are equal to the average cost.
